Determining what counts as compensation for your plan can sometimes be confusing, especially when you are paying amounts to participants who have left employment.
When someone leaves employment, you may or may not be able to use their final compensation amounts for plan purposes, such as withholding employee 401(k) deferrals, or calculating an employer match or other contribution. You can always use final compensation for participant loan payments, but you should check with the participant first before withholding these amounts.
Wages for services rendered, such as regular compensation, overtime, shift differential and commissions and bonuses, are always included.
Unused accrued sick, vacation or leave pay would be included if the participant would have received this payment if still employed.
Unfunded deferred compensation may be included as long as your plan allows.
Severance payments, such as salary continuation to participants due to a layoff, are NEVER included. The IRS position is the individual receiving severance pay is no longer an employee and thus is no longer performing services for you. This means, any severance compensation they receive cannot be used for 401(k) elective deferrals, or in the compensation used for determining employer contributions to the plan.
To be included as plan compensation, payments must be made within a certain time frame. The payments must be made by the later of:
- 2-1/2 months after the employee leaves employment, or
- End of the plan year that includes the employee’s severance from employment with you.
If you are ever unclear if a payment to a terminated participant counts as compensation or not, your Plan Consultant would be happy to guide you.